by Frank Schnittger
Wed Aug 3rd, 2016 at 03:13:21 PM EST
The Brexit vote has already had an effect on consumer confidence and investor sentiment in the UK with the Governor of the Bank of England warning of the likelihood of at least a technical recession in the near term. A prolonged period of uncertainty is unlikely to improve that outlook in the medium term, but at least the UK can use Sterling devaluation, monetary policy easing, and reduced rates of corporate tax to mitigate its worst effects in the short term. That is, however, of no comfort to Irish exporters to the UK who are heavily dependent on the UK market - especially the small and medium sized indigenous sectors of the economy.
Indeed the whole Irish economy is heavily integrated with the UK economy although that dependency has reduced markedly since entry into the EU. Exports to the UK currently amount to c. 14% of total exports with the USA, Belgium and Germany accounting for 20%, 13% and 8% respectively. An official report for the Irish Government has estimated that Brexit could result in an average 20% reduction in trade flows between Ireland and the UK and the OECD has estimated that Ireland's GDP will be reduced by 1.2% as a result.
That official report is also pessimistic that Ireland can make up the difference by increasing its share of FDI that would otherwise have gone to the UK. Despite the proclamations of popular economists like David McWilliams that "Brand Britain is ours for the taking", it estimates that the ability of Dublin to attract business from London will be limited by Sterling devaluation, reduced UK corporate tax rates, and a shortage of suitable office space, housing and schools in the greater Dublin area. Nevertheless, the shape of the Irish government and corporate response to the Brexit crisis (or opportunity) is now becoming clear:
Dublin in pole position to take business from City of London
As the race to capture any financial services fall-out from London post-Brexit heats up, Dublin has emerged as the second most attractive financial centre in Europe, and may stand to gain the most from Brexit, a new PwC survey says.
PwC's financial services attractiveness indicator has ranked Dublin as the second most attractive of the major European financial centres, with London in the top spot. Luxembourg, Paris and Vienna rank third, fourth and fifth respectively. Frankfurt is in seventh position.
Dublin ranked particularly strongly for the strength of legal rights, its ease of doing business, and talent. However, it was below the average score of the other eight financial centres for the availability of domestic credit for the private sector
Presumably the availability of domestic credit will not be a major factor in the location decisions of global financial services players and other major corporates. Some observers and players are already seeing straws in the wind indicating the direction in which it may be blowing:
Dublin in pole position to take business from City of London
"The UK's potential loss of EU market access, including passporting benefits, poses great uncertainty in financial markets. While Ireland and Dublin offers certainty on access to the Single Market and EU passporting, other factors such as an English-speaking, flexible and highly skilled workforce, a pro-business environment and a strong and stable legal system are also positives. Brexit is causing many uncertainties. We are already seeing some UK financial services organisations making enquiries on relocating to Ireland and only time will tell how this will develop," said Damian Neylin, PwC Ireland head of financial services.
Indeed, US fund manager Fidelity is set to move a significant number of jobs from its current operation in Surrey in the UK to Dublin - although this is said to be unrelated to Brexit - while insurer Beazley is working to get European insurance licences for its Irish reinsurance business to allow it to operate throughout the European Union.
Ken Owens, PwC Ireland Brexit leader for financial services, says PwC is predominantly seeing enquiries in the areas of banking, management companies in the asset management industry and MIFID (Marketing in Financial Instruments Directive) firms.
Given that the UK attracts c. 30 Billion in FDI each year to Ireland's 5 Billion, it would take a transfer of only a small part of the UK's share to Ireland to make a major difference to the Irish economy. However we are talking longer term here whereas the effect on exports is much more immediate. The Irish economy was estimated to have grown by 7.8% last year even before that figure was upgraded to a ludicrous 26% GDP growth due to the activities of major corporates re-locating their IP, contract manufacturing, and aircraft leasing balance sheets to Ireland, and so some cooling down of the Irish economy in the near term may not be altogether a bad thing. We do not want a return to the boom and bust days of the Celtic Tiger.
Bertie Ahearn, disgraced former Taoiseach in the boom to bust years used to gauge the health of the Irish economy by looking out his office window and counting the number of cranes in operation. At least he wasn't relying entirely on those dodgy GDP figures. As I write the Dublin sky line is beginning to fill up again, partly to address a chronic Dublin housing shortage, but also, I suspect, to meet an expected boom in the demand for high end office and executive accommodation post Brexit. The UK has been warned: it is in your interest to expedite the Brexit negotiations as quickly as possible and to retain access to the Single Market for financial services if at all possible. Dublin does not share your anxiety about foreign immigrants.
However the effect on the Irish economy of an FDI boom would be very asymmetric, exacerbating the already apparent tendency to grow Dublin relative to the more rural regions of Ireland. In addition, the small and medium indigenous enterprises (mainly in the food sector) who are heavily dependent on trade with the UK and who are vulnerable to devaluation as well as Brexit are predominantly located in more rural areas. Krugman has an interesting piece up on how the impact of the internet has not had the expected effect of advantaging more rural areas relatively to big cities. Instead, he argues, it has facilitated the unbundling of previously integrated head office functions with HQ's often moving back to the City while back office functions and customer service centres remain decentralised. If these trends are realised, the Irish Government will face a very disgruntled rural electorate unless it can redirect significant investment and jobs their way.
The other problem with any resultant growth in the globalised sector of the Irish economy is that it will make the Irish economy even more dependant on foreign owned as opposed to indigenous businesses. What can come in quickly and easily can also leave quickly and easily. To date, that has not been much of a problem as relatively few major global corporates (notably Dell) have significantly divested from Ireland, and that has often been for reasons of corporate decline rather than relocation elsewhere. However we should be under no illusions that any businesses attracted to Ireland due to Brexit will prove to be any more loyal to Ireland than they were to the UK if the going gets tough.
One of the longer term implications of Brexit is that Ireland will lose a close ally (and common law partner) within the EU. Ireland's low corporate tax rate and general economic development model will come under much more pressure from an EU sans the UK. Brexit may also therefore herald the end of a prolonged honeymoon period in Ireland's membership of the EU. And that is even before we address the thorny issue of Northern Ireland. We live in interesting times...